Yes, The Dollar Is Losing Its Status as Reserve Currency

JP Morgan noted last year that “reserve currencies” have a limited shelf-life:

As the table shows, U.S. reserve status has already lasted as long as Portugal and the Netherland’s reigns. It won’t happen tomorrow, or next week … but the end of the dollar’s rein is coming nonetheless, and China and many other countries are calling for a new reserve currency.

Why China Doesn’tWant the Yuan to Become the Reserve Currency

But a switch to a totally-different system – say, a gold-backed yuan – would cause enormous disruption and chaos. China – which has been a long-term planner for thousands of years – doesn’t want such a sudden change.

Moreover, housing the world’s reserve currency is a huge burden, as well as a privilege. Venture Magazine notes:

The inherent burden of housing the world’s reserve currency is that the U.S. must continue to run a balance of payment deficit to meet the growing demand. However, it was this outstanding external debt that caused investors to lose confidence in the value of the reserve assets.

Michael Pettis – the well-known American economist teaching at Peking University in Beijing – explains:

A world without the dollar would mean faster growth and less debt for the United States, though at the expense of slower growth for parts of the rest of the world, especially Asia.

***

When foreigners actively buy dollar assets they force down the value of their currency against the dollar. U.S. manufacturers are thus penalized by the overvalued dollar and so must reduce production and fire American workers. The only way to prevent unemployment from rising then is for the United States to increase domestic demand — and with it domestic employment — by running up public or private debt. But, of course, an increase in debt is the same as a reduction in savings. If a rise in foreign savings is passed on to the United States by foreign accumulation of dollar assets, in other words, U.S. savings must decline. There is no other possibility.

***

By definition, any increase in net foreign purchases of U.S. dollar assets must be accompanied by an equivalent increase in the U.S. current account deficit. This is a well-known accounting identity found in every macroeconomics textbook.So if foreign central banks increase their currency intervention by buying more dollars, their trade surpluses necessarily rise along with the U.S. trade deficit. But if foreign purchases of dollar assets really result in lower U.S. interest rates, then it should hold that the higher a country’s current account deficit, the lower its interest rate should be.

Why? Because of the balancing effect: The net amount of foreign purchases of U.S. government bonds and other U.S. dollar assets is exactly equal to the current account deficit. More net foreign purchases is exactly the same as a wider trade deficit (or, more technically, a wider current account deficit).

So do bigger trade deficits really mean lower interest rates? Clearly not. The opposite is in fact far more likely to be true. Countries with balanced trade or trade surpluses tend to enjoy lower interest rates on average than countries with large current account deficits — which are handicapped by slower growth and higher debt.

The United States, it turns out, does not need foreign purchases of government bonds to keep interest rates low any more than it needs a large trade deficit to keep interest rates low. Unless the United States were starved for capital, savings and investment would balance just as easily without a trade deficit as with one.

***

Only the U.S. economy and financial system are large enough, open enough, and flexible enough to accommodate large trade deficits. But that badge of honor comes at a real cost to the long-term growth of the domestic economy and its ability to manage debt levels.

For the reasons outlined by Pettis, China – which has the world’s 2nd biggest economy (or 1st … depending on the measure used) – doesn’t want the burden of housing the world’s reserve currency.

As such, China is pushing for a basket of currencies to replace the dollar as reserve currency.

Jim Rickards – one of the leading authorities on currency, having briefed the CIA, Pentagon and Congress on currency issues – says:

China is not buying gold to create a new gold standard; rather it is aiming to make the Yuan more attractive, with the end result of being included in a basket of currencies, referred to as the Special Drawing Rate (SDR). He added that there is a move to make the SDR the new global reserve currency.

“Everybody knows that the U.S. dollar’s days are numbered but there is no really currency to take its place except for the SDR,” he said. “What the world is trying to do is move to the SDR and China is fine with that.”

Rickards added that China’s goal of being in an SDR basket is the best of both worlds; the country can still have total control over its monetary policy and capital accounts but still influence global economics by being part of a basket of currencies.

“What the Chinese want is to have the Yuan in the SDR basket but not open up their capital account,” he said. “That is a backdoor way for the Yuan to be a de facto reserve currency without having to give up control.”

What’s Missing?

It is silly to exclude the Yuan from the basket of currencies.

Indeed, given that there are privileges and burdens of having the reserve currency, I would argue that – if we are going to move away from the dollar as sole reserve currency – all of the currencies of the world could be in the basket … in proportion to the size of their economies. It is simple to look up the GDP of the world’s nations.

That way, each country would all share in the benefits and costs, in proportion to its size and strength.

(Obviously, some countries have such small or unstable economies that no one would want to settle in their currency. To be realistic, they’d probably be dropped out of the basket. But the ideal of including everyone is worth maintaining.)

Keynes and Other Economists Say We Should Use a Basket of Commodities

While having a basket of different things acting as the world’s reserve currency may sound like a new idea, John Maynard Keynes – creator of our modern “liberal” economics in the 1930s – promoted a basket of 30 commodities called the “Bancor” to replace the dollar as the world’s reserve currency.

The arguments for currency fixed on a basket of commodities – as opposed to currencies – was that it would stabilize the average prices of commodities, and with them the international medium of exchange and a store of value.

As China’s head central banker said in 2009, the goal would be to create a reserve currency “that is disconnected from individual nations and is able to remain stable in the long run, thus removing the inherent deficiencies caused by using credit-based national currencies”. Likewise, China suggested pegging SDRs to commodities.

Economics Professor Leanne Ussher of Queens College in New York concludes that a reserve currency made up of a basket of 30 or so commodities would:

The idea of a commodity-based currency may seem to some a step backwards to a more primitive form of exchange. But in fact, from a practical point of view, commodity-secured money (for example, gold- and silver-based money) is the only type of money that can be said to have passed the test of history in market economics. The kind of unsecured currency (bank notes and treasury notes) presently used by practically all countries has been acceptable only for about half a century, and the judgment of history regarding its soundness still remains to be written.

With a commodity-based currency, a central bank could issue a New Currency backed by a basket of from three to a dozen different commodities for which there are existing international commodity markets. For instance, 100 New Currency could be worth 0.05 ounces of gold, plus 3 ounces of silver, plus 15 pounds of copper, plus 1 barrel of oil, plus 5 pounds of wool.

This New Currency would be convertible because each of its component commodities is immediately convertible. It also offers several kinds of flexibility. The central bank would agree to deliver commodities from this basket whose value in foreign currency equals the value of that particular basket. The bank would be free to substitute certain commodities of the basket for others as long as they were also part of the basket. The bank could keep and trade its commodity inventories wherever the international market was most convenient for its own purposes–Zurich for gold, London for copper, New York for silver, and so on. Because of arbitrage between all these places, it doesn’t really matter where the trades would be executed, as the final hard currency proceeds would be practically equivalent. Finally, since the commodities also have futures markets, it would be perfectly possible for the bank to settle any forward amounts in New Currency, while offsetting the risks in the futures market if it so desired.

This flexibility results in a currency with very desirable characteristics. First of all, the reserves that the country could rely on–actual reserves plus production capacity–are much larger than its current stock of hard currencies and gold. The New Currency would be automatically convertible without the need for new international agreements. Since the necessary international commodity exchanges already exist, the system could be started unilaterally, without any negotiations. Because of the diversification offered by the basket of several commodities, the currency would be much more stable than any of its components–more stable, really, than any other convertible currency in today’s market.

3 Choices for a More Stable Money System

The 2 choices for reserve currency discussed above are using a (1) basket of currencies or (2) basket of commodities.

A third choice – which may be the best – is to use a mixture.

For example, we could have 50% currencies and 50% commodities.

That would give us some of the desirable characteristics (like stability) of a commodity basket, but not immediately move away from the fiat money systems which are now status quo for the current system.

Any of these 3 choices would give us far more stability and prosperity than we have today … without the chaos and misery – especially for Americans and perhaps Chinese – that switching to a Yuan-only reserve currency would bring.

Notes: You might assume that public banking advocates would be for a currency-only basket. But Bernard Lietaer was one of leading public banking advocate Ellen Brown’s main teachers, and he is pushing for a basket made up solely of commodities. (But public banking advocates might argue for adding currencies to the basket currencies to allow for some elasticity in the money supply.)

Gold standard advocates would obviously prefer commodities to currencies. A basket of commodities might not have the simplicity of a gold standard, but it would accomplish a lot of the same goals.

As an American who wants stability and prosperity for my country, I think a basket would be the best option for a healthy future for the U.S. And as someone who wants good things for the rest of the world, I believe that a basket would help to share political influence more widely.

Despite the author’s graph showing the end of the dollar as a reserve currency, the article is naive.

Nothing happens permanently in economics by edict, or agreements between nations to create a currency swap agreement. In fact, these currency swap agreements being negotiated by China are indicative of the absolute strength of the dollar, and nothing more important than that. The U.S. dollar does not require currency swap agreements.

The loss of reserve currency status for the dollar would require so many events (defaults), it’s unlikely the dollar can ever lose reserve currency status because it is so widely held throughout the world. One of the effects of the Bernanke money drops all over the world has been to completely dollarize the world. The demand for dollars has been astonishing since the 2008-2009 collapse, especially in the face of all this Bernanke money printing-and-distribution all over the world.

Bernanke has repeatedly bailed out everyone in the world, to one degree or another, and the dollar still stands in great demand.

That’s at the macro level or economics. I have friends who are Iranians. I have repeatedly asked them, were I in Iran (of all places) and in a marketplace, were I to offer to pay for a purchase with one hand holding Iranian money and the other hand holding U.S. dollars, which would the vendor prefer? The answer is always the same, that the vendor would not hesitate to reach immediately for the U.S. dollars.

The problem with understanding competing currencies is not unlike the bi-metal problem. When both gold and silver coins were in circulation in the U.S., people tended to hold onto the gold coins and spend the silver ones. The more reliable gold coins were stored away, and, the inferior silver ones lost value because of their commonplace in the market. The same effect is what gives the dollar its seemingly immutable strength. Think of the amount of money Bernanke has printed. And what has changed that couldn’t be attributed to being what Bernanke wanted to happen? e.g. rising prices versus falling prices.

So, this article is simply talking about the Man in the Moon catching a cold, when it talks about the dollar losing reserve currency status. That’s impossible in today’s world. It grows less possible, every day.

If the U.S. could be beaten in a world war, yes, the reserve status of the U.S. dollar would evaporate. like Confederate money. So, if you want to talk about the U.S. dollar losing its reserve status, show me a scenario where the U.S. loses a world war and our nation must surrender to a hostile power.

FAT-CHANCE!

Concerned Sovereign

WOW, you are so under a delusion its not funny. Good luck champ…

Tonto

WOW, you are obviously under a delusion imparted to you by all the half-wit, Libertarian fortune tellers on the Internet. I bet you bought gold at $1900, and cheated your state out of the sales tax for same. Good luck with THAT chump. They’ll catch up with you eventually.

Here’s an article for all the other brainless halfwits out there that proves you’re all financial geniuses. It’s dated June 29, 2011, “Updating: 90 Analysts Who Foresee $5,000/oz or More Gold | Resource Investor”

yep, you are correct in all of your statements. all is well and nothing will ever change despite the fact that debtlevels are rising exponetially, and growth is pretty much non-existant. /golfclap

Tonto

And just what are you expecting to change? Since the advent of the fed, debt levels have risen exponentially. So, what? Do you really believe that this depression is going to make the people of the world to want to live like the average barefoot coolie in China? /Monty Python canned laughter

Try reading a good book for once. You’ve simply got to stop reading the same thing you’ve been reading over and over again on the Internet since about 2000. Michael Rivero, Jeff Rense and Alex Jones (and about a thousand other Internet copy-cats) have been predicting the collapse of the country since who knows when. Haven’t you ever noticed they’re always begging for donations? Donations? None of them are looking -sane- these days cooped-up in that spare bedroom in their Tel Aviv condos. The world doesn’t run on donations except in the mind of all these ubiquitous Internet soothsayers of doom, gloom, revolution, conspiracy and Star Trek fantasy. It’s just a depression fad, you know, like dance contests and flag pole sitting.

Predictions of collapse of the dollar go back so far, anyone that listens to them now falls right in line with a long list of flat-earthers and second-coming losers.

None of it is the least bit credible….

Voice of Reason

Tonto,

Welcome back. What
does how “the people of the world want to live like” have to do with
anything? “The people of the world”
don’t call the shots (literally and figuratively) – unless you count financiers
and bankers as people. I think I’ve
recommended a book here before to you – or at least here: Frederick Soddy’s “Wealth, Virtual Wealth and
Debt” (2nd edition if you can find it). In it Soddy explains that, whatever ‘the
people’ may want, the logic of international banking (AKA free flow of capital-AKA
free trade or globalization) DEMANDS a ‘race to the bottom for the 99.999%. I’m surprised you of all people would make
the mistake of believing what ‘the people’ want has anything to do with the
price of tea in China.

But Soddy may go deeper than most people want to go in
discussing the difference between real wealth and debt. So here is a quick summation for those who
only read the Reader’s Digest condensed version of books: money is DEBT not wealth – and it is far
easier to create. More to the point,
after one already has a claim to more wealth than can be consumed in several
lifetimes, the pursuit of more money is the only thing that can give their
lives meaning. That’s what members of
the 0.001% mean when they say the only use of the money they make is to ‘keep
score’.

You need that background to really appreciate one more book
recommendation, “Super Imperialism” by Dr. Michael Hudson. Like Britain
before us, the United States
has become a nation of traders, financiers and bankers. Why go to the trouble and risk of making
something when you can get people who actually do create or control real wealth
to turn it over to you in exchange for certificates of indebtedness? (Marx predicted this when he suggested
capitalism would eventually eliminate the commodity production phase of money
making – the ‘c’ in “m – c – m’”.)

But how do I say this politely when I criticize your
optimistic conclusion that this national free lunch will go on forever? You are WRONG, WRONG, WRONG! Like the Germans before them, the Chinese ARE
actually creating wealth (admittedly along the environmental pollution that may
well kill off all the people obtaining the wealth creation skills). But unlike the Germans, the Chinese are good
at playing the long game.

They could of course make a mistake and challenge the status
quo of Western nations exporting their wealth creation skills while sinking
further into the morass of fraudulent accounting too soon. But if their timing is right, at some point
they (the Chinese) will be able to say “No more of your fraudulent
promises!” And there won’t be a damn
thing the US
can do about it. The only skills left in
the imperial homeland of the Empire of Debt will be consumption and Ponzi
scheme creation.

“The end of history.”
Really? From you, Tonto? I’m disappointed.

Tonto

Huh? You’re disappointed in me?

Look. What I am saying is, there’s no way anyone can claim they have the timing of the collapse of the empire down to a science. Why so?

Because it’s been predicted by these same morons over and over again, without their being even remotely close to hitting anything they’ve called a target, (like $5000 gold predicted in the 2011 article referenced above). It’s just not going to happen. America is stronger today than it has ever been in its history, despite having doubtlessly the most corrupt federal administration since Grant. (Obama is simply not up to the task, and he never claimed he was.)

So, -we can know- all these doom and gloom predictions are not about truth. These predictions are about frustrated end-of-the-worlders who are missing out on everything the economy currently offers to those who are real entrepreneurs. The losers are clearly those who are sitting in their bunkers, hoarding gold and stock-piling guns, ammo and TP.

I buy into an investment on the cheap. Gold is not cheap. Guns are not cheap. Ammo is not cheap. TP is not cheap.

I am in the process of buying a piece of land that was planted with Norway Spruce forty years ago. This is big beautiful wood, all in rows and spaced properly so the limbs are very small heading skyward. It only needs to be finished off properly, which should take a matter of 10-20 years. When it’s finished, it will be as golden as gold ever thought of being. To make the deal sweeter, this parcel abuts (surrounds actually) an old farmhouse my son and daughter-in-law bought two years ago. It’s only 26 acres, and only about half is planted in spruce. It’s the investment opportunity of a lifetime. The taxes are modest, with a mil rate of just 14.25. The neighbors are accommodating and friendly. The area is as upscale as it gets in northern Maine, where I reside far from the maddening cities where everyone pays too much for everything, and getting ripped-off is a way of life.

I’d love to read your referenced book. I read all kinds of things, though mostly history and philosophy, because I’ve found in my studies the sciences are not what they appear or claim to be. Someone at some point suggested I read Human Action, by von MIses. As a philosopher of some renown, I can authoritatively tell you and everyone else here, Ludwig von Mises rates about a .5 in a scale of 1 to 10, when it comes to understanding economics. He obviously never ran a business, and had no understanding of how markets work, or what money is in the hands or eyes of a businessman. Von Mises philosophical background is sophomoric and even laughable.

I’ve been tabulating my reads for a couple of years. You can view them here, with reviews. I am currently reading Clark Clifford, -Counsel to the President-.

Anyway, if you’re trying to tell me this depression will cause the downfall of the American Empire, I telling you flat out, the rest of the world -with few exceptions- is feeling this demographic depression much worse than we are.

I will quote Will Durant about the last depression he lived and published through. “Even in a depression, this is a very rich country.”

So, don’t be disappointed in me. Try and read with a little more comprehension, and then come back at some time in the future, to see if all the foolish predictions others are making actually come true (like public banking and the end of the fed). I believe in a steady state universe. And in that sense, nothing is about to change despite there being a depression going on. Look to position yourself for the future, not predict it.

Tonto

Here’s another bit of propaganda-turd to gum up your infantile conception of Internet reality.

MSN News is right now running a story entitled “Forgotten bitcoins buy man home”.

Now, how the hell do you suppose MSN got hold of this sort of rosy-eyeglasses story about bitcoins, if it didn’t come from the spooks in Washington DC who are pushing this bitcoin scam?

There’s a sucker born every minute. Raise your, fools.

Buzzkill

Geez Tonto….. what’s the matter? Forgot to take your pills today and now you can’t find your way back to the wigwam.
What an annoying human being!

Tonto

Yeah, reality can really suck when you’re having a bad day, a bad week, a bad month, a bad year, and a bad life, eh, BUZZKILL? Dope does that to the human psyche. You’ve gotten so strung out on euphoria, coming down off the stimulants makes one kind of lashing-out-cuckoo. Go look in the mirror, Buzzy. Those were once, your teeth.

Tonto

Yeah, reality can really suck when you’re having a bad day, a bad week, a bad month, a bad year, and a bad life, eh, BUZZKILL? Dope does that to the human psyche. You’ve gotten so strung out on euphoria, coming down off the stimulants makes one kind of lashing-out-cuckoo. Go look in the mirror, Buzzy. Those were once, your teeth.

Stanley Boonguh

tonto please grow up you are so lost in mainstream.

Voice of Reason

Well, why didn’t you say so? I’m still disappointed in you Tonto. You have such a command of the English language there simply is no excuse for my confusion. There is still the matter of your disdain for science. Do you shun hammers for the same reason, i.e. that the democratic masses – or at least those they purportedly choose to lead themselves – are too vicious to be trusted with them? Then there is the matter of your economic behavior – all rational choices but how far do you think they are going to get you in a world run by ‘traders’? It looks to me like you believe right thinking my eventually pay off! You of all people should know better!

Thanks BTW for the reading list. I’ve hit at least some of them and look forward to checking out the rest

Stanley Boonguh

tonto wake up read the news youtube new no country wants the dollar!!!figure it out smart guy.

wunsacon

I don’t buy this:

>> Moreover, housing the world’s reserve currency is a huge burden, as well as a privilege. Venture Magazine notes: “The inherent burden of housing the world’s reserve currency is that the U.S. must continue to run a balance of payment deficit to meet the growing demand. However, it was this outstanding external debt that caused investors to lose confidence in the value of the reserve assets.”

That’s no “burden”! It’s an exorbitant privilege to be able to print more promises in exchange for real goods and services. So what if someday that gravy train ends! Better to ride as long as possible than walk along the tracks the entire way.

I 4 I, Tooth 4 Tooth my s

Not if the gravy train ride ends in an ugly crash. Unless you know the exact moment when the crash is coming (not likely), you may find yourself with a bunch of $ that will not buy you 1/3 of what you thought they would, and have to rearrange all your plans for the future life.

wunsacon

You’re focusing on the cost but seem to be ignoring the benefit entirely.

Yes, there’s a bit of pain for one generation after several generations of sucking up the world’s resources without paying them anything of value. During those several generations, you build up your infrastructure, invite in as many of the world’s smartest people as possible to study/work for you, build up your science and technology lead, build bases abroad and effectively manage the locals by building relationships and doling out “foreign aid” to friendlies.

Some commenters on ZH refer to “Obama’s Free Shit Army”. Frankly, even the “fully employed” are part of a “Free Shit Army” because we buy imported electronics, autos, whatever. A country like China pollutes itself and maintains Dickensian labor conditions while shipping us their stuff in return for “promises”. That’s “free shit” right there. And anyone still drawing discretionary income (e.g., our uberwealthy royalty and most of the still-employed) *still* benefit from this relationship.

Great stuff folks…Very interesting. It’s a shame that there are only eighteen comments on this thread, and probably just one more indication of America’s transition from the Information-Age into the Age-of-Narcissism-and-Ignorance, that there is such sparse interest? Maybe the author should have named the piece “is-the-dollar-really-losing-its-reserve-status-before-Miley-Cirus-sings-pantyless, in order to get more views? In economics, like in physics, there are no free lunches, and so begs the question of how long the rest of the World will continue to pay for America’s current lunch?

Mohammad Sahid

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DungeonMasterKey

Very Interesting. I think it is unfair to place all this burden on the US. A basket of currencies seems more democratic and would increase international monetary cooperation, perhaps.

DungeonMasterKey

Another quick note: The idea of a basket of currencies to me sounds a lot like shares in a company. The whole world economy starts to act like a corporation. It’s a neat idea.